As commentators focus on this early morning’s price action,
including some notable gapping dynamics, investors are well
advised to keep an eye on underlying market liquidity. The
“sucking sounds” of prior days are getting louder as four factors
come together. And while not a "Lehman Moment," investors should
be careful as such nasty market technicals can feed onto
themselves.

Dislocated liquidity conditions
-- as in wider and more volatile bid-offer spreads, considerably
less intermediation appetite among dealers, etc. -- are cascading
down from the most levered market segments. The direct and
immediate causes are:

Greater market volatility
forcing more formulaic and VAR-based accounts to reduce
positions in an accelerated fashion

Crossover
investors trying to get back to their “home asset classes,” and
finding it hard to do so in an orderly fashion

An outflow of
funds from mutual funds and other accounts; and, of
course,

Reduced
willingness among dealers to make markets and, in the process,
resisting to hold much inventory

In essence, the
liquidity underpinnings of markets can no longer support the
overall positioning of investors overly comforted by the
prolonged and repeated interventions of hyper active central
banks using experimental policies.

Determining whether this is
just a temporary blip or what economists call a “multiple
equilibrium” (i.e., rather than mean revert, an unpleasant
outcome increases the probability of a subsequent worse outcome)
is essentially a call on two main issues: the health of the
underlying fundamentals relative to market pricing, and the
availability of balance sheets to step in with stabilizing
liquidity.

Given current indicators, this
periodic phase of dislocation in market liquidity -- and they do
occur occasionally -- is likely to continue in the immediate
period ahead.